“Excuse me as I kiss the sky”
-How High, Method Man & Redman
I heard that Song for the first time in probably 10 years last night on the way home from coaching basketball.
If you grew up in the 90’s, you probably know it. If you came up in the 90’s as a local bball star running around playing pickup in the projects every day, it needs no introduction.
If you aren’t any of those things, you probably just don’t get it. It’s okay. Despite the Hedgeye hockey pedigree and having been indoctrinated in it for a decade, I still don’t always get it.
Anyway, the rap recipe for SoundScan success in the 90’s was straightforward. Find anyone with 16 bars of slick talk then just put Nate Dogg (#RIP) on the hook. Guaranteed commercial success. It really was that easy.
If you cut your teeth in the 90’s as an econ on the back side of the inflation curve, the rate recipe for success was equally straightforward. Lower highs and lower lows in the policy rate. It really was that easy.
Remember, undressed of its academic vagaries and layered theoreticals, the core conceptual underpinning for conventional policy is exceedingly straightforward.
Expansionary policy aims to lower the real interest (widening the spread between the real rate and the marginal product of capital) in an attempt to support growth via investment and consumption (interest rate effects) and net exports (currency effects).
In other words:
- Lower rates = higher domestic investment demand and higher demand for interest rate sensitive consumption = ↑ Growth
- Lower rates = less demand/more supply of dollars = depreciating Currency = ↑ Exports = ↑ Growth
And so long as there remains sufficient distance between the current policy rate and some terminal lower bound (which, as we’ve learned, is less than zero), the recipe is simply more cowbell … in successively larger quantities capable of subsuming the prior cowbell and any outcroppings of capital malfeasance that policy may have cultivated.
It’s Wednesday and with Europe dropping its latest single (February Eurozone confidence ↓, Italy Consumer Confidence ↓), which is really just a remix of the same deceleration song they’ve been singing for a year+, disharmonic geopolitical risks percolating, former lead guitarist in the Trump fixer band set to testify and harmonized global deceleration and rising complacency again threatening to break up the Cowbell reflation concert, it’s again time for (macro risk) Regulators to Mount Up.
Back the Global Macro Grind ….
Let’s keep this running homage to 90’s hip hop nostalgia going, shall we.
How High …. Inventory Hoarding?
Import front-loading and inventory hoarding ahead of impending tariff implementation is the macro-gdp accounting equivalent of channel stuffing and was on conspicuous display in 2018. In the present case, the explicit aim was to front-run tariff implementation & thus reduce costs. This also a quasi-case study in the fallacy of composition (ie. what is good for the individual is not good/less good for the whole). Here, if everyone is import hoarding, then warehouse capacity collapses & storage costs increase as does the likelihood for transportation and other bottlenecks to drive logistics costs higher. And if this is occurring against a backdrop of slowing demand and all that inventory needs to be discounted to be moved well .... than that is just not factor cocktail supportive of improved profitability and margin expansion, particularly as you comp against peak earnings cycle comps. Raising costs in an effort to reduce costs is kind of like increasing tariffs on China only to see the yuan depreciate to the pint of fully offsetting the tariff increase before those tariffs even go into effect.
How High …. 1Q GDP Distortions?
This is a derivative of the inventory developments highlighted above but its worth a separate mention. The Chart of the Day below shows the USDA’s weekly read on Soybean exports to China. From a bigger picture perspective, exporting a bunch of soybeans is largely insignificant. But from a GDP accounting perspective, it can have an outsized impact. We saw this same dynamic manifest conspicuously last year as soybean exports jumped ahead of tariff implementation in 2Q18. The rise served to drive a meaningful increase in agricultural exports which resulted in a pronounced improvement in the trade balance. Indeed, net exports made their largest contribution to Headline Growth of this cycle at +1.22 pts. Of course, we saw the converse in the next quarter as the distortion reversed.
How High …. Policy Distortions?
The longer I do this the more convinced I am of the need to occasionally reiterate ostensibly obvious things. Here, the reminder is simply that while globalization aspires to full and open trade, the global economy is a closed system and is pareto constrained in the short-term. In other words, if the Chinese buy significantly more from us in the service of placating political concerns around the trade imbalance, they are buying less from someone else, at least at the margin. And if global growth and global trade are both slowing in the aggregate, that someone else (cough, Draghi) could see compound pressure on external demand. A smaller slice of a smaller pie is not the stuff sustainable tightening cycles are made of.
How High …. Confidence Rebound?
The Conference Board’s Consumer Confidence Index followed the University of Michigan reading higher in February, rebounding +11.2 pts sequentially across the Headline.
As we highlighted in contextualizing the preliminary Univ of Michigan reading, the rebound is encouraging and probably allays some concerns around a terminal cyclical spiral following some of the steepest multi-month declines of the cycle/decades in recent months.
On the other hand, the bar was set pretty low as January reflected the collective impact of the government shutdown, the discrete pickup in negative macro data flow (globally and locally), further escalation in political/policy brinksmanship and the residual sentiment shock from the peri-holiday crescendo in market volatility.
Frankly, if the baseline expectation wasn’t for a modest-to-moderate bounce in the wake of the shutdown resolution, the relief rally in equities, still solid labor data and some constructive trade/tariff headline flow, it probably reflects the harboring of some willful non-objectiveness.
In any case, fully distilled, it mostly boils down to a bounce to lower highs amidst a trending decline off the 2018 cycle peak. Best not to overthink it.
How High …. PHS rebound?
Lastly, How High will Pending Home Sales bounce this morning? The PHS data for January which will offer the lead read on closed transaction volume for February and the first real signs of whether the decline in interest rates, a still strong domestic labor market and progressively easier 2019 comps can staunch the multi-year bloodletting in existing market volume growth. Yesterday’s Housing Starts data for December was an unequivocal brick … but that was stale, shutdown-delayed December data and the rate-of-change flavor of the print was a known-known. With a fledgling shift to ‘less bad’ in both the February Builder Confidence data and the Jan/Feb Mortgage Purchase Application - both of which represent the first reflections of the backslide in interest rates - we expect January Pending Home Sales to reflect another baby step in the direction of stabilization.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.60-2.70% (bearish)
SPX 2 (neutral)
RUT 1 (neutral)
NASDAQ 7 (bullish)
Utilities (XLU) 55.12-57.39 (bullish)
REITS (VNQ) 82.86-85.50 (bullish)
Housing (ITB) 34.02-36.20 (bullish)
VIX 13.33-18.47 (neutral)
USD 95.60-97.17 (bullish)
Oil (WTI) 53.05-58.25 (bullish)
Nat Gas 2.50-2.91 (bearish)
Gold 1 (bullish)
Copper 2.73-3.01 (neutral)
Best of luck out there today,
Christian B. Drake
U.S. Macro Analyst
